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3. Consider a market where two factors are sufcient to describe the returns on conunon stocks. For an asset i, the asset's expected return is

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3. Consider a market where two factors are sufcient to describe the returns on conunon stocks. For an asset i, the asset's expected return is given by E[r1-} = rf + u P1 + Biz P2, where P} and P2 are the factor premiums (expected return of the factors in excess of the risk-free rate). Both factors are independent. The following table gives the sensitivities of the stocks ABC and PQR to the two factors, as well as the expected returns of each stock: (a) Consider a portfolio, C, made up by selling short $.50 of security PQR and purchasing $1.50 of ABC. How sensitive will this portfolio be to each of the two factors? (13) Consider a portfolio, D, made up by borrowing $1.00 at the risk free rate and investing $1.00 in portfolio C. How sensitive will this portfolio be to each of the factors? (c) "Wifiat combination of securities ABC, PQR and the riskless security will move on a one- to-one basis with factor 1 and be insensitive to factor 2

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